Managerial Accounting and Cost

Concepts
Chapter 1

Managerial Accounting
Seventeenth edition
 1-2

Needs of Management
Financial accounting is concerned with
reporting financial information to external
parties, such as stockholders, creditors, and
regulators.

Managerial accounting is concerned with

providing information to managers within an
organization so that they can formulate plans,
control operations, and make decisions.

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 Case study: Profit of a Pho restaurant

Opportunity

Variable

Product
Indirect

Period
Mixed
Fixed
DM
3000 bowls of Pho @ 50.000/pho

DL
Revenue 150.000.000,00
Expenses
Meat 30.000.000
Bones 3.000.000
Noodles 9.000.000
Vegetables 1.500.000
Other foods 600.000
Electricity 5.000.000
Depreciations 3.000.000
Rent* -
Cook salary 9.000.000
Waiter wage 6.000.000
Marketing expenses 3.000.000
Owner Manager** -
Total taxable expenses
Earning Before Tax
Tax (20%)
Profit
* Owner' house which can be rented for 15 million/month
** Owner can earn 10 millions/month if work for other companies
How much profit is estimated if 3,000 bowls sold? If 4,000 sold?
What factors affect the cost per unit?
 1-4

Purposes of Cost Classification

1. Assigning costs to cost objects

2. Accounting for costs in manufacturing
companies
3. Preparing financial statements
4. Predicting cost behavior in response to changes
in activity
5. Making decisions

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 1-5

Learning Objective 1

Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs.

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 1-6

Assigning Costs to Cost Objects

Direct costs Indirect costs
• Costs that can be • Costs that cannot be easily
easily and conveniently and conveniently traced to
traced to a unit of product a unit of product or other
or other cost object. cost object.
• Examples: direct material • Example: manufacturing
and direct labor overhead

Common costs
• Indirect costs incurred to support a number of cost
objects. These costs cannot be traced to any
individual cost object.

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 1-7

Learning Objective 2

Identify and give examples

of each of the three basic
manufacturing cost
categories.

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 1-8

Classifications of Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

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 1-9

Direct Materials
Direct materials are raw materials that
become an integral part of the product and
that can be conveniently traced directly to it.

Example: A radio installed in an automobile

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 1-10

Direct Labor
Direct labor costs are those labor costs that
can be easily traced to individual units of
product.

Example: Wages paid to automobile assembly

workers

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 1-11

Manufacturing Overhead
Manufacturing overhead includes all
manufacturing costs except direct material
and direct labor. These costs cannot be readily
traced to finished products.

Includes indirect materials Includes indirect labor costs

that cannot be easily or that cannot be easily or
conveniently traced to conveniently traced to
specific units of product. specific units of product.

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Manufacturing Overhead –
1-12

Examples
Examples of manufacturing overhead:
• Depreciation of manufacturing equipment
• Utility costs
• Property taxes
• Insurance premiums incurred to operate a
manufacturing facility

Only those indirect costs associated with

operating the factory are included in
manufacturing overhead.

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 1-13

Prime Costs and Conversion Costs

Manufacturing costs are often
classified as follows:

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost

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 1-14

Nonmanufacturing Costs

Selling Administrative
Costs Costs

Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.
Selling costs can be Administrative costs
either direct or indirect can be either direct or
costs. indirect costs.
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 1-15

Learning Objective 3

Understand cost
classifications used to
prepare financial
statements: product costs
and period costs.

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 1-16

Product Costs
Product costs includes all the costs that are
involved in acquiring or making a product.

Product costs “attach” to a unit of product as it

is purchased or manufactured and they stay
attached to each unit of product as long as it
remains in inventory awaiting sale.

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 1-17

Manufacturing Product Costs

For manufacturing companies, product costs
include:
• Raw materials: includes any materials that go
into the final product.
• Work in process: consists of units of product
that are only partially complete and will require
further work before they are ready for sale to
the customer.
• Finished goods costs: consists of completed
units of product that have not yet been sold to
customers.
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 1-18

Transfer of Product Costs

• When direct materials are used in production, their
costs are transferred from Raw Materials to Work in
Process.
• Direct labor and manufacturing overhead costs are
added to Work in Process to convert direct materials
into finished goods.
• Once units of product are completed, their costs are
transferred from Work in Process to Finished
Goods.
• When a manufacturer sells its finished goods to
customers, the costs are transferred from Finished
Goods to Cost of Goods Sold.

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 1-19

Cost Classifications for Preparing

Financial Statements
Product costs include direct Period costs include all
materials, direct labor, and selling costs and
manufacturing overhead. administrative costs.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

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 1-20

Quick Check 1
Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

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 1-21

Quick Check 1a
Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E Sales commissions.

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 1-22

Learning Objective 4

Understand cost
classifications used to
predict cost behavior:
variable costs, fixed costs,
and mixed costs.

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 1-23

Cost Classifications for Predicting Cost

Behavior

Cost behavior refers to how a cost will

react to changes in the level of activity.
The most common classifications are:
• Variable costs.
• Fixed costs.
• Mixed costs.

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 1-24

Variable Cost

A cost that varies, in total, in direct

proportion to changes in the level of
activity.

A variable cost per unit is constant.

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 1-25

An Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours
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 1-26

Fixed Cost

A cost that remains constant, in total,

regardless of changes in the level of
the activity.

If expressed on a per unit basis, the

average fixed cost per unit varies
inversely with changes in activity.

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 1-27

Types of Fixed Costs

Committed Discretionary
Long-term, cannot May be altered in the
be significantly short-term by current
reduced in the short managerial decisions
term

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 1-28

The Linearity Assumption and the

Relevant Range

Economist’s A straight line

closely
Curvilinear Cost approximates a
Function curvilinear
variable cost
line within the
Relevant
relevant range.
Total Cost

Range
Accountant’s Straight-Line
Approximation (constant
unit variable cost)

Activity
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 1-29

Fixed Costs and the Relevant Range

The relevant range of activity pertains to fixed cost as

well as variable costs. For example, assume office space
is available at a rental rate of $30,000 per year in
increments of 1,000 square feet.

Fixed costs would increase in a

step fashion at a rate of $30,000 for
each additional 1,000 square feet.

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 1-30

Relevant Range: Graphic

90
Rent Cost in Thousands

The relevant range of

Relevant activity for a fixed cost
60
of Dollars

Range is the range of activity

over which the graph
of the cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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 1-31

Comparison of Cost Classifications for

Predicting Cost Behavior

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 1-32

Quick Check 2
Which of the following costs would be variable
with respect to the number of ice cream cones
sold at a Baskin & Robbins? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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 1-33

Quick Check 2a
Which of the following costs would be variable
with respect to the number of ice cream cones
sold at a Baskin & Robbins? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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 1-34

Mixed Costs – Part 1

A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.

Y
Total Utility Cost

ost
d c
x e
al mi
To t
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-35

Mixed Costs – Part 2

Y
Total Utility Cost

o st
d c
ix e
al m
Tot Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
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 1-36

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
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 1-37

Learning Objective 5

Understand cost
classifications used in
making decisions: relevant
costs and irrelevant costs.

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 1-38

Cost Classifications for Decision Making

Decisions involve choosing between

alternatives. The goal of making decisions is
to identify those costs that are either
relevant or irrelevant to the decision.
To make decisions, it is essential to have a
grasp on the concepts of differential costs
and revenues, opportunity costs, and sunk
costs.

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 1-39

Differential Costs

Differential costs (or incremental costs) are

the difference in cost between any two
alternatives.
A difference in revenue between two
alternatives is called differential revenue.
Both are always relevant to decisions.
Differential costs can be either fixed or
variable.

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 1-40

Opportunity Cost
The potential benefit that is
given up when one alternative is
selected over another.

These costs are not usually found in

accounting records but must be
explicitly considered in every decision.

For students: What is the opportunity cost you

incur by attending class?
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 1-41

Sunk Costs

Sunk costs have already been incurred and

cannot be changed now or in the future.
These irrelevant costs should be ignored when
making decisions.

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 1-42

Quick Check 3
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of the
train ticket relevant in this decision? In other
words, should the cost of the train ticket affect the
decision of whether you drive or take the train to
Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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 1-43

Quick Check 3a
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of
the train ticket relevant in this decision? In other
words, should the cost of the train ticket affect the
decision of whether you drive or take the train to
Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

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 1-44

Quick Check 4
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual
cost of licensing your car relevant in this
decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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 1-45

Quick Check 4a
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual
cost of licensing your car relevant in this
decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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 1-46

Quick Check 5
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

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 1-47

Quick Check 5a
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

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 1-48

Learning Objective 6

Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.

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 1-49

The Traditional and Contribution

Formats

Used primarily for Used primarily by

external reporting. management.

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 1-50

Uses of the Contribution Format

The contribution income statement format is used
as an internal planning and decision-making tool. We
will use this approach for:
1.Cost-volume-profit analysis (Chapter 5).
2.Segmented reporting of profit data (Chapter 6).
3.Budgeting (Chapter 8).
4.Special decisions such as pricing and make-or-buy
analysis (Chapter 13).

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 1-51

End of Chapter 1

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